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Euro faces a key test
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August 14, 2000: 11:23 a.m. ET
If currency hits a new record low, it might get some help from the ECB
By Gordon Platt
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NEW YORK (CNNfn) - The flustered euro is hovering just above its record low of 88.49 U.S. cents and is facing a key test. If it drops to new lows, it will risk a major breakdown that could require the European Central Bank to come to its rescue.
The euro steadied just above 90 cents in early trading Monday, and market participants were watching nervously to see if it could regain some strength.
"The European Central Bank is worried that weakness in the euro will result in inflation," said Bob Lynch, currency strategist at BNP Paribas. The threat is that higher import prices will be passed on to the consumer.
The ECB is expected to raise interest rates at its next meeting, and it could be forced to raise them sharply if the euro continues to weaken.
 "The euro will test its record low, but it won't break it," Lynch forecast.
The problem for the euro boils down to what is happening in the United States, he said. Gains in productivity suggest that the U.S. economy can grow at a faster rate than thought without causing inflation.
"This has resulted in an attractive real rate environment in the United States," Lynch said.
The dollar won't move past its May highs on the euro, however, unless more U.S. economic data come in on the strong side of expectations, he said.
Bob Sinche, head of global currency strategy at Citicorp, said the Federal Reserve will stay on hold at least until Nov. 15.
Assuming that the Fed does not raise rates at the Aug. 22 meeting, the approach of the presidential election will make the Fed reluctant to act, Sinche said.
"It would require more than the usual amount of evidence to convince the Fed to tighten at the Oct. 3 meeting," he said.
This pause could provide an opening for the European Central Bank to shift the interest-rate differential in the euro's favor.
In its monthly report last week, the ECB sounded more hawkish than usual, Lynch of BNP Paribas said. "It signaled that a rate hike is likely in September, and that the only question is whether it will be 25 or 50 basis points," he said.
The ECB said the euro's decline "remains a concern."
"It should remain a concern," said Dennis Gartman, editor and publisher of The Gartman Letter. The competitive benefits of a weak currency to European manufacturers are now outweighed by the threat to price stability, he said. As goods imported into Europe that are priced in U.S. dollars or Japanese yen become more expensive, those price increases will be passed on to the consumer.
As the ECB put it, "All in all, upper risks to price stability in the medium term continue to prevail." The central bank wants this to be stopped, Gartman said.
The market may be getting ready to reassess the euro's fortune. Backers said the currency could get a boost from next week's report from the Institute on German business confidence, which is expected to be strong.
Analysts at Chase Securities said the euro could have a short-term bounce, but they remain skeptical on the euro in the long term.
The euro seems to have reached a no-win position against the dollar, they said. Heads, the dollar wins, and tails, the euro loses.
A slowing U.S. economy has been seen as dollar-positive, because it reduces the risk of aggressive Fed tightening that could derail the stock market. If the economy had accelerated, and the Fed had raised rates even more, the higher rates would have supported the dollar.
While the recent release of second-quarter U.S. productivity data showed that the U.S. economy has increased its growth potential once again, Euroland so far has failed to show a substantial improvement in productivity.
Investment flows into Europe will increase only once it becomes evident that the continent is enjoying more than a cyclical upturn, the Chase analysts said.
European restructuring will be a time-consuming process, they added.
The Japanese yen strengthened slightly Friday after the Bank of Japan ended its zero-interest-rate-policy and raised interest rates for the first time in a decade. The move was seen as a sign of confidence in Japan's economic recovery.
"There was a sense of relief that the worst didn't happen and that (Central Bank Governor Masaru) Hayami wasn't forced to resign," Sinche of Citicorp said.
Hayami had been pressured strongly by Japan's political leaders, including Prime Minister Yoshiro Mori, not to raise rates. 
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